What’s behind an ESG rating?
Issue #75: A weekly update on responsible investment. Forwarded by a friend? Subscribe here.
I found an excellent resource this week digging into what is inside an MSCI rating that I would like to highlight in this week’s newsletter. As ESG ratings are still a (relatively) new phenomenon — I often hear both companies and investors wanting to understand what exactly is going into an ESG rating.
The resource begins by sharing about the various data sources MSCI pulls into when creating a rating. In this case MSCI pulls from over 1,000 data points including:
- Company filings: Proxy reports, sustainability reports, shareholder results, voluntary company ESG disclosures
- NGOs: Global Reporting Initiative (GRI), Sustainability Accounting Standards Board (SASB), UN Sustainable Development Goals
- Government: U.S. Environmental Protection Agency, European Central Bank, EU Taxonomy
- Media sources: Major headlines
- Alternative data: Geo mapping, water scarcity data, flood risk analysis
It then breaks down some further aspects of the ESG rating process beginning with: The fundamental questions:
- Which ESG issues could cause harm to investors?
- Which ESG issues may create opportunities relative to their peers?
If you read the resource directly you can dig further into the E, S and G topics MSCI digs into as well as understand how their ratings work thanks to a hypothetical case study with an oil and gas company.
Corporates doing good:
The Lost Forest: Brew Dog
“Introducing The Lost Forest. We purchased a huge chunk of land in the Scottish highlands where we will embark on the single biggest native woodland establishment and peatland restoration project ever carried out in the UK. Located just west of Aviemore, work will begin at the Lost Forest in August after we have completed our environmental surveys. We will be planting millions of native trees to create a bio-diverse broadleaf woodland and ecosystem. Overall, the Lost Forest is capable of pulling 1 million tonnes of carbon dioxide out of our atmosphere.”
- James Watt, BrewDog CEO and Founder on LinkedIn.
Top Stories
Race & Ethnicity and the Role of Asset Stewardship
Cyrus Taraporevala from State Street Global Advisors shares on his journey with the role of race and ethnic diversity when it comes to Asset Stewadship. He concludes sharing:
“The point is, every company in the world is on a journey when it comes to diversity — which is why it is important to be transparent about these challenges, to be quite candid about the challenges and not pretend anybody’s perfect. We certainly know we’re far from perfect on this at State Street. But I am very encouraged by our progress — since our CEO and Chairman made a commitment last summer, we have added Black and Latinx representation to our board. I am very proud. 23% of our Board directors are from underrepresented communities, and 31% of our Board are women. That’s a start, a good start — but we still have a long way to go. What that tells me is that not only we all have work to do — but the sooner we acknowledge where we are falling short, the sooner we can begin to make progress. That is the power of disclosure … of providing that window … and of looking into that mirror.”
What I Wish I Had Learned About Investing At Harvard Business School III: ESG Compensation Targets And Risk-Adjusted Returns
51% of the S&P 500 uses ESG targets in their incentive plans. The vast majority of companies in ESG-intensive sectors like utilities (90%) and energy (83%) use ESG targets in executive compensation, while only one-third of consumer discretionary (30%) and information technology (34%) companies do so. Similarly, according to a recent PwC and the London Business School’s Center for Corporate Governance report, 45% of FTSE 100 companies use an ESG measure when setting targets for executive pay.
How To Spot An AI Ethics Watermelon
“A watermelon in the ESG space is a company that looks ‘green’ on the outside, but look too deeply below the surface and all sorts of risks become apparent. 25 years ago, it was impossible to tell the difference between companies who had the interests of wider society at heart from those who just had a photo in their brochure of their annual charity run. By 2021 the asset management industry has matured such that fund managers demand data from ESG Market Data providers who provide ratings and scores as to the ‘green’ credentials of an organisation. Commitment to carbon neutral by 2030? Great! — but prove how you are going to operationally deliver that. With ESG ratings, you can smell a watermelon from afar.”
Charles Radclyffe on Forbes.
Where do I start with ESG reporting?
Determine your end goal. Start by asking yourself, where do you want to go? What is it that your company trying to accomplish around ESG and sustainability initiatives? Once you understand your end goal, you can begin to determine which of the frameworks can get you there.
- Are your goals focused on investor interest? Sustainability Accounting Standards Board (SASB) and their 77 industry standards, tend to look at ESG through the investor’s lens.
- Do you want to focus on social metrics? The Global Reporting Initiative has been around for many years. It has established a great framework that incorporates environmental, economic, and social metrics, which could align nicely with Social goals you’re trying to accomplish.
- Are you broadening your initiatives? Perhaps your program is really advanced, and you’ve already reported to GRI, or perhaps the Carbon Disclosure Project, and want to know what you should do next. Start by looking internationally at the UN’s Sustainability Development Goals, or the World Economic Forum. JD Supra.
Aviva Investors raises climate risk concerns with finance ministers
The £366bn asset manager has previously warned public companies over inaction on global warming, but the letter to finance ministers and central bankers is the first time it has written to sovereign issuers, reflecting “the importance of their role in global efforts to address climate change”. Aviva called on the recipients to take several steps, such as setting out ambitious so-called nationally determined contributions, the actions each country will have to take to reduce national emissions and adapt to the effects of climate change.
Financial Times.
*Want to make your ESG processes digital, schedule a call to see a demo of Nossa Data’s software via emailing: team@nossadata.com
(Academically-oriented) Opinion Highlight
Investing for Good by Tom Gosling.
“How should we invest to support progress towards addressing climate change?
In this article I’m going to try to work my way through these complex arguments. I’m going to focus on climate change, but the principles could apply to other environmental or social issues. In almost all cases, you can replace [climate change] by [your favourite environmental or social concern].
I’m going to focus on how investors can best help bring about change on climate issues through their investment decisions. I’m setting aside for now the question of whether this has a cost in terms of returns (as you’ll see we’ve enough to cover as it is). I’ll come back to the trade-off question in a separate article.”
Five roads to virtue
He goes on to discuss the pros / cons of making a positive impact on climate change for each of the strategies. Here is the summary reel:
Divestment: Divesting from fossil fuel companies in their equity portfolios doesn’t seem to be a very effective way for retail investors to exert economic influence on climate change. Any impact will be through the political signalling of such an action. Finding a bank that doesn’t finance fossil fuel debt (especially coal) is likely a better divestment strategy.
Tilting: Tilting as an approach to climate-friendly investing has strong evidential underpinning, and can be implemented without completely cutting exposure to fossil fuel sectors. It is also a strategy that can be extended across all sectors.
Engagement: Engagement produces results and is an important component in the armoury of any climate-aware investor.
Impact: Directing our money towards narrowly focused impact funds is likely to contribute to increased valuations for companies that benefit from those funds. Whether this leads to greater investment remains a difficult question to answer, and currently the case is not made.
Integration: Investing in funds that follow an Integration strategy increases the efficiency with which ESG factors are priced into the market. This encourages firms to follow ESG strategies where they lead to long term shareholder value. However, this strategy does not enable investors to drive change faster than financial market forces dictate, unless combined with another strategy.
Other useful resources:
Is the focus on executive pay misguided? Can ESG ratings be made uniform? And which companies are best placed to get us beyond fossil fuels?
Everything you need to know about ESG by London Business School. Read the resources.
What content do you want to see next week?
Nossa Data aims to curate content on responsible investment and ESG to support leaders around the world in staying informed. Keep us posted on the content that is most relevant for you to learn about by replying to this email. We will do our best to include it in a future issue.
Kind regards,
The Nossa Data Team
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Julianne Sloane
Co-founder of Nossa Data
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